As the name implies, a limited partner in a partnership is a partner, in contrast to a general partner, who has liability for partnership debts only to the extent of the limited partner's investment in the partnership. The Fifth Circuit majority in Sirius Solutions used these definitions of limited partner under state and federal law to conclude that being a limited partner did not require being a passive investor, other than in the context of guaranteed payments under Code Sec. 707(c), rejecting the position of the IRS and Tax Court.
However, now the Fifth Circuit in Sirius II, K Alain LLLP v. Commissioner No. 24-60240, is reverting to something like a passive requirement, but still rejecting the Tax Court analysis. The dissent in Sirius I continued in Sirius II.
Sirius I
The issue involved in Sirius I (Sirius Solutions LLLP v Commissioner, No. 24-60240 (5th Cir. Jan. 16, 2026)) was the self-employment tax liability of limited partners under Code Sec. 1402(a)(13).
The IRS has developed a functional analysis looking at a partner's level of participation to determine whether the partner is subject to self-employment tax. A limited partner's distributive share of partnership income is generally excluded from self-employment tax except for guaranteed payments for services. Code Sec. 469 treats limited partner interests as per se passive activities unless the taxpayer meets material participation standards. Reg. Sec. 1.469-5T defines active participation as only satisfying one of three limited material participation tests, compared to seven for non-limited partners. In practice, many limited partners become functional general partners under these tests.
Looking at historical definitions of limited partner, state law under limited partner statutes, and even IRS language in forms and instructions, the Fifth Circuit case was heard by a three-judge panel. The two-judge majority concluded that there was no support for introducing a passive investor requirement to be a limited partner and concluded that a limited partner could not be subject to self-employment tax under those requirements, reversing the Tax Court on the same issue. A limited partner is simply a state-law limited partner with limited liability, with no functional analysis required. The dissent filed by the third judge was in support of the Tax Court position.
The IRS did not accept the Fifth Circuit decision.
Sirius II
In the January 2026 opinion in Sirius I, the Fifth Circuit had stated that a limited partner qualifies under Code Sec. 1402(a)(13) if the person is a limited partner in a state law limited partnership and has limited liability. In Sirius II, the language has been revised to provide that a limited partner is "a partner who plays no significant role in managing or running a business." The Fifth Circuit in Sirius II did not provide detailed standards for what constitutes "significant control." Instead, it remanded the case for a facts and circumstances evaluation.
Passive investor
What is the difference between the Tax Court's position compared to the new Fifth Circuit position?
The IRA and Tax Court looked at whether the partner is a passive investor. The Fifth Circuit in Sirius II asks whether the partner plays a significant role in managing or controlling the business. Sirius II seems to contemplate that there is not a strict passive investor requirement.
The IRS and Tax Court look at the level of activity of the partner while the Fifth Circuit focuses on the degree of management authority and business control of the partner. It is not clear where the line is drawn between the two. It is clear that both now require a functional inquiry.
Soroban Capital and Denham Capital
The Tax Court in Sirius I had cited its previous decision in Soroban Capital (151 T.C. 310 (2003)). That decision is on appeal to the Second Circuit. Another case, Denham Capital (T.C. Memo 2014-114), was similarly decided by the Tax Court as a memorandum decision and is currently on appeal to the First Circuit.
The Department of Justice in a letter to the First Circuit Court of Appeals seems to indicate that the test applied in Sirius II is viewed as consistent with the IRS position in Denham.
Planning
The Fifth Circuit decision in Sirius II only applies in the states of Louisiana, Mississippi and Texas. Taxpayers who were hoping to take advantage of the more liberal and straightforward interpretation of limited partner in Sirius I now must do a more difficult analysis of whether the partner may be considered to possess significant management authority or business control.
Outside of the Fifth Circuit, the IRS is still doing a functional analysis of the level of non-passive activity in the business. It may be said that the IRS and Tax Court still have a passive investor requirement while the Fifth Circuit does not, but it may be a distinction without much difference.
It is interesting that the dissent in Sirius I in support of the IRS standard, relying on the "limited partner, as such" language of Code Sec. 1402(a)(13) and other definitions, still felt that it was necessary to continue the same dissent in Sirius II. Taxpayers in the First and Second Districts will want to continue to monitor developments in the Soroban and Denham cases.
While the Fifth Circuit majority in Sirius I seemed to try to limit its decision to limited partnership situations, that language was not included in Sirius II. The Sirius II analysis may, therefore, also apply to limited liability companies.
